1.(U)SUMMARY: As Brazil enjoys its recent strong pattern of economic
growth, many observers question the sustainability of this growth
given the poor condition of Brazil's infrastructure. One critical
element in supporting future growth will be Brazil's ability to
provide a reliable electrical supply. The country is currently
heavily dependent on hydroelectricty without much diversification,
leading to difficulties in years with light rainfall. Chief of Staff
Dilma Rouseff says that by 2020 current resources will be
insufficient to meet the demand, while some outside the government
caution that problems could arise as early as 2009. Brazil faces
many challenges in its ability to ensure sufficient electrical
generation capacity, and while there are long term plans to address
the deficiency, the current generation capacity remains just barely
sufficient. END SUMMARY.

------------------
WHAT IS THE NEED?
------------------

2. (U) Apart from a slowdown in the 1980s during a period of low or
negative economic growth, Brazil's energy consumption has been
increasing at a rate higher than the world average. According to
the Ministry of Mines and Energy (MME), energy consumption decreased
from 332 TW-hour/year (tera - or trillion - watts) in 2000 to 310
through rationing in 2001 and since that time has risen at an
average of 5% per year, which is also Brazil's target rate of GDP
growth. By 2007, the rate of consumption had risen to 435 TW-hours
and is predicted to be 533 TW-hours by 2011. Data from the national
electrical system unified operator, ONS, shows that maximum demand
for 2007 was 64,000 megawatts (MW) and they predict by 2011 that
will rise to 79,000 MW. This compares with an installed capacity of
98,000 MW in 2007 and a predicted 109,000 MW in 2011. However,
sector experts note that installed capacity figures can be
misleading, particularly since Brazil's capacity is heavily
influenced by rainfall levels and actual production frequently falls
short of capacity.

-----------------
RELIANT ON HYDRO
-----------------

3. (U) According to the World Energy Council (WEC), Brazil has the
world's third highest potential capacity for hydroelectricity after
China and the U.S., and is the third largest producer of hydro-power
after Canada and the U.S. Brazil's dams are located primarily in
the heavily populated southeast, but there are smaller dams
throughout the country which are linked into the national power
grid. The largest dam, Itaipu, is owned jointly with Paraguay with
a 50-year contract that is due to expire in 2023. (Note:
Paraguayan president-elect Lugo made renegotiating more favorable
terms on the Itaipu contract a central part of his campaign
platform. The GOB has said they are unwilling to renegotiate the
contract, but in the days following the Paraguayan election have
indicated a willingness to work on a solution outside of the
contract. The Brazilian Congress has been vocal in its opposition
to any contract renegotiation in the wake of Lugo's victory. End
Note.)

4. (SBU) Pricing electricity that is dependent on water levels can
be an art not a science, AES Electropaulo CFO Alexandre Innecco
explained to Econoff. The national electrical regulatory body,
ANEEL, sets an assured energy capacity for each hydro-generation
plant based on average river flows. ONS, in turn, controls how much
water is dispatched via the various rivers based on reservoir
levels, and upstream/downstream activity and determines which
generators will produce and how much. Hydroelectric plants can only

BRASILIA 00000672 002 OF 004

contract electricity up to their assured capacity; however, a plant
can conceivably generate less than its contracted energy and would
have to purchase electricity either on the bilateral electricity
market (where generators can trade excess energy generated above
assured capacity) or on the spot market. Innecco explained,
however, that contracted hydroelectric generators generally are not
authorized to buy on the spot market and face penalties that
effectively double the spot price.

---------------------------
Other Sources of Electricty
---------------------------

5. (U) Aside from hydroelectricity, other renewables do not play a
significant role in Brazil's electrical supply, although there are
reports that the new Super Eletrobras may be charged with expanding
into these areas. There is significant interest in developing
electrical production based on the next generation ethanol, some of
which already provides electricity for ethanol factories (septel).
As measured by the speed and regularity of prevailing winds,
according to the WEC, wind energy is an untapped area with high
potential in Brazil, especially in the areas of the Northeast that
do not have sufficient water supply for hydroelectric dams. Growth
in this area remains constrained for many reasons, including a high
tariff on the import of wind generation equipment. The result is
that Brazil has one of the world's lowest rates of installed wind
capacity, and the growth rate in this area has lagged behind that of
other countries.

6. (SBU) Nuclear energy makes up a very small part of Brazil's
electricity generation - its two nuclear plants in Rio de Janeiro
State make up only about 2% of production capacity in the country.
Although Brazilian officials, including MME Minister Lobco in a
conversation with Ambassador Sobel, have indicated Brazilian
interest in taking advantage of Brazil's large uranium reserves to
become a yellow cake exporter, in the near term any civil nuclear
expansion will be minimal. In the long-term however, Chief of Staff
Dilma Rouseff confirmed during Senate questioning on May 6 that the
government has long term plans to expand civil nuclear generation
even beyond construction of the long-anticipated third reactor.
Brazil's long-term desire to increase their civilian nuclear program
is in part delayed by the fact that, as World Bank Director Briscoe
told Econoff and Ministry of Foreign Relations Director for
Non-renewable Energy Vivian Loss San Martin confirmed, the GOB
contracted the building of the third nuclear plant at the time of
construction of the two existing ones, leaving a warehouse full of
already purchased 1970s equipment that the government must now
figure out how to update with its French and German partners in
order to move ahead, as they clearly intend to do.

7. (U) Brazil's thermo electrical plants run largely on coal, of
which Brazil does not have sufficient quantities, and gas, which
also requires imported sourcing. Petrobras is installing new
liquefied natural gas plants this year to augment thermal capacity
(reftel A). Over the medium-term, new sources of natural gas at
Tupi and Sugar Loaf (reftel F) will provide a new, domestic source
of natural gas for the potential expansion of thermal electric
plants.

----------------
Challenges
----------------

8. (SBU) ANEEL General Director Jerson Kelman told Econoff that one
of the biggest challenges to Brazil's energy sector is increasing
production in an efficient and environmentally friendly way. As
APINE president, Luiz Fernando Leone Vianna, also pointed out in a
separate conversation echoing Kelman's, the current permitting and
licensing system makes the building of hydroelectric dams very
challenging due to societal and environmental concerns which
perversely makes the more polluting, carbon heavy, non-renewable
conventional thermoelectric plants much easier to build. The World

BRASILIA 00000672 003 OF 004

Bank has recently completed a study which addresses this and other
complications in energy licensing in Brazil, making recommendations
in an attempt to ease the licensing challenges to electric companies
seeking to operate in Brazil.

9. (SBU) The independent energy suppliers association, ABRACEEL,
believes the governmental role in the concessions process has led to
the distortion of the system. ABRACEEL President Paulo Pedrosa told
Econoff, that this year's concerns over a possible energy crisis
were not due to true generation limitations, but rather a shortage
of supply caused by the government's artificial intervention in the
system of auctions to keep prices low. He points to government
understatement of the actual demand contracted at auction as a way
of decreasing the number of contracts for suppliers to vie for. In
so doing, interested suppliers bid the price lower in an attempt to
gain the contracts. This tactic not only results in lower energy
prices for the consumer but lower energy supply for the coming year
as well.

10. (SBU) Also, as Brazil seeks to diversify its electrical
generation base, it must contend with their current lack of other
conventional resources such as coal and gas. They must rely on
imports and have in the past been caught on the short end of the
stick with unreliable regional suppliers. Bolivia for example
reneged on their contract with Petrobras, successfully demanding a
renegotiating. Bolivia just this year tried to reopen the issue to
pursue the GOB to cede part of its gas supply from Bolivia to
Argentina, an offer the Lula government firmly declined. Argentina
as well has not lived up to its gas contracts and generally fails to
supply the level of gas to Brazil that the two sides had negotiated.
(Reftels A and B)

11. (U) Finally, according to ONS, the current dilemma in management
of the electrical system is how to optimize the use of the
hydropower available. Having reached the limits of its current
capacity, Brazilian electrical regulators must optimize the
electrical supply they have available. What percentage of
hydroelectric power to reserve for the dry season and to what extent
to utilize the stop gap measure of thermoelectric capacity is a
perennial puzzle. Since thermo power is much more expensive, ONS
tell us they would prefer to minimize its use in favor of hydro.
However, failure to predict demand or rainfall correctly may mean
insufficient hydropower for the year. This could cause authorities
to find themselves on the wrong side of the spot market for coal-
and gas-generated thermal electricity - leading to very painful cost
hikes, most likely to affect industry and, therefore, potentially
overall GDP growth. Or, in the worst case scenario, authorities
could be driven to impose rationing or risk blackouts. On the other
hand, trying to compensate early in the season with thermo power,
having incorrectly anticipated a shortage of rainfall, may lead to
the more economically efficient hydro supply going to waste and
electricity costs rising unnecessarily due to the employment of
thermal. This juggling act is becoming more precarious as Brazil's
thirst for electrical power equals its capacity for generation.

12. (SBU)COMMENT: As Brazil looks to continue on its path of strong
economic growth, capitalizing on the recent decision by Standard and
Poor's to upgrade Brazil's foreign currency sovereign credit rating
to investment grade (reftel E), they may find this growth
constrained by limits in the electricity sector. The Lula
government is searching for ways to expand the generation capacity,
presenting areas ripe for possible bilateral and regional
cooperation as well as potential U.S. investment. In the meantime,
the government finds itself having to do a precarious balancing of
limited resources in the electrical sector to avoid rationing and
possible blackouts on one hand, or spikes in electrical costs on the
other. The nature of the challenge and Brazil's attempts to control
it will be the subject of the next cable in this series. END
COMMENT.

13. (U) This cable was written in conjunction with Sao Paulo and
coordinated throughout Mission Brazil.

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